3 Reasons the Cloud Is Huge for AMZN Stock

It's a small slice of sales, but a slice with bigger margins

Amazon (AMZN) was pushed higher last week thanks to both the broader market’s tailwind and good news out of the Amazon Web Services (AWS) segment. Namely, a judge ruled that Amazon can continue working on the cloud computing contract with the CIA that in won back in January — and Amazon stock made a big technical bounce as a result.

The green light means Amazon now boasts a big-time government contract worth up to $600 million over four years.

Sure, that’s pocket change for AMZN considering the whopping $61 billion in revenues it brought in last year. But the contract is a promising sign of what might be in store for Amazon stock investors.

AMZN by the Numbers

Of course, Amazon doesn’t explicitly break out AWS revenue, because AMZN only explicitly breaks out whatever it feels like breaking out. (Kindle sales, anyone?) But we do know that AWS is one of many Amazon “services.” According to the 2012 Amazon 10-K, the services segment includes third-party seller fees earned and non-retail activities such as AWS, advertising services and Amazon’s co-branded credit card agreements. In 2012, total services sales for AMZN were $9.36 billion.

Amazon also breaks its sales down by “media,” “electronics and other general merchandise” and “other,” which counts sales from non-retail activities — including AWS in the North America segment. For 2012, the North America “other” total was $2.35 billion for AMZN. Analysts currently estimate that AWS generates roughly $3 billion in annual revenue.

No matter how you slice it, it’s clear the AWS total is a small sliver of the company’s $61 billion total, making up less than 5% of its overall sales if we use analyst numbers.

But it’s still a promising sign for investors in Amazon stock — for three big reasons:

#1: Thicker AMZN Margins

While the bulk of the AMZN revenue comes from e-commerce, that business is saddled with a huge problem: slim margins. As Jeff Reeves wrote about Amazon stock recently:

“Of course, the million-dollar question is how Amazon can subsist by selling everything at razor-thin profit margins. Part of the appeal isn’t just the convenience and scale of AMZN, but also the low prices that the e-commerce giant offers.”

So while AMZN keeps growing revenue at a breakneck pace, its earnings per share have been negative in two of the past four quarters and missed estimates in four of the past five. Right now, Amazon is slated to post a third-quarter loss of 9 cents per share — the same loss it posted for 2012.

“Gross margin increased in 2012, compared to the comparable prior year periods, primarily due to services sales increasing as a percentage of total sales.”

The bottom line: AWS might not drive a notable portion of revenue right now, but it sure as hell drives margins and thus the ever-difficult task of spinning revenue into profits.

#2: Big-Time Growth for AMZN

Even though it’s a small slice of the pie, AWS is a huge growth engine for Amazon.

The aforementioned services segment grew 54% year-over-year for 2012 — more than double the 23% growth of products. And the vague “other” that includes North America’s AWS posted rocketing 64% YOY growth that handily dwarfed the 15% and 24% growth from the two remaining segments.

Plus, AWS is a bigger player in cloud computing than most consumers realize. While tech-first names like Hewlett-Packard (HPQ), Citrix (CTXS), Oracle (ORCL) and VMware (VMW) are all trying to get a slice of the market, AMZN is actually ahead.

According to a report from research firm Gartner, the AMZN cloud computing service is “the overwhelming market share leader” in cloud infrastructure, and has more than five times the capacity of the next 14 rivals Gartner follows … combined.

#3: The AWS Reputation

“Handling so-called mission-critical operations and ultra-secure data isn’t where AWS initially made hay. Some competitors and even some corporate tech buyers still dismiss AWS as technology provided by an online bookseller, suggesting it’s not capable of handling the demands essential to running government agencies and companies in the business of managing sensitive data.

So while there are examples of AWS running mission-critical operations, a contract from the CIA could put remaining questions to rest. That’s why the contract is so important to Amazon.”

The bottom line: Don’t write off the Amazon AWS contract because it’s a small slice of the revenue pie. It comes with a lot to like, including thicker margins, big-time upside and general validation.

Those are all things that Amazon stock investors should be cheering.

As of this writing, Alyssa Oursler did not hold a position in any of the aforementioned securities.